PREFERENCES: WHAT THE

CONSUMER WANTS
• All wants of a consumer cannot be fulfiled with
limited resources. So a consumer ranks up his
desires and builds up a scale of preferences.
• A consumer’s scale of preferences is
independent of the prices ruling in the market.
• A consumer is striving hard to reach a level of
equilibrium i.e. a position in which he derives
maximum satisfaction from the use of money at
his disposal.
 Consumer preference :
assumptions
• Ordinal Utility
• Consistency
• Transitivity
• A consumer’s scale of preference is independent of
his income , prices of the goods in the market , and
scale of preferences of another consumer.
• A consumer prefers more to less.
• One combination can be substituted for another.
• Indifference curve is convex to the origin and shows
diminishing marginal rate of substitution.
 PREFERENCES: WHAT THE
CONSUMER WANTS
• A consumer’s preference among
consumption bundles may be illustrated
with indifference curves.
 INDIFFERENCE CURVE
• An indifference curve is a locus of all such
points which show different combinations
which yield equal satisfaction to the
consumer.
• On the indifference curve the consumer
becomes indifferent about his choice.
 Figure 2 The Consumer’s Preferences

Quantity
of Pepsi

Indifference
curve, I1
0 Quantity
of Pizza
Copyright©2004 South-Western
 SLOPE OF INDIFFERENCE
CURVE
• The Marginal Rate of Substitution
– The slope at any point on an indifference
curve is the marginal rate of substitution.
• It is the rate at which a consumer is willing to trade
one good for another.
• It is the amount of one good that a consumer
requires as compensation to give up one unit of
the other good.
 Law of Diminishing Marginal Rate
of Substitution
• Acc to the law , as a consumer gets more
and more units of X , he will be willing to
give up less and less units of Y.
• In other words, MRS of X for Y will go on
diminishing while the level of satisfaction
of the consumer remains the same.
 Figure 2 The Consumer’s Preferences

Quantity
of Pepsi
C

B D
MRS I2
1
Indifference
A
curve, I1
0 Quantity
of Pizza
Copyright©2004 South-Western
PROPERTIES OF INDIFFERENCE
CURVE
• Indifference curves are downward sloping.
• Indifference curves do not cross.
• Indifference curves are bowed inward.
• Higher indifference curves are preferred to
lower ones.
 Property 1:
• Indifference curves are downward sloping.
– A consumer is willing to give up one good only
if he or she gets more of the other good in
order to remain equally happy.
– If the quantity of one good is reduced, the
quantity of the other good must increase.
– For this reason, most indifference curves
slope downward.
 Figure 2 The Consumer’s Preferences

Quantity
of Pepsi

Indifference
curve, I1
0 Quantity
of Pizza
Copyright©2004 South-Western
 PROPERTY 2
• Indifference curves are convex to the
origin.
This property is based on the law of
diminishing marginal utility.
 Figure 4 Bowed Indifference Curves

Quantity
of Pepsi

14

MRS = 6

A
8
1

4 B
MRS = 1
3
1
Indifference
curve

0 2 3 6 7 Quantity
of Pizza
Copyright©2004 South-Western
 PROPERTY 3
• Higher indifference curves are preferred to
lower ones.
– Consumers usually prefer more of something
to less of it.
– Higher indifference curves represent larger
quantities of goods than do lower indifference
curves.
 Figure 2 The Consumer’s Preferences

Quantity
of Pepsi
C

B D
I2
Indifference
A
curve, I1
0 Quantity
of Pizza
Copyright©2004 South-Western
 PROPERTY 4
• Indifference curves do not intersect .
– Points A and B should make the consumer
equally happy.
– Points B and C should make the consumer
equally happy.
– This implies that A and C would make the
consumer equally happy.
– But C has more of both goods compared to A.
 Figure 3 The Impossibility of Intersecting
Indifference Curves

Quantity
of Pepsi

0 Quantity
of Pizza
Copyright©2004 South-Western
 Two Extreme Examples of
Indifference Curves

• Perfect substitutes
• Perfect complements
Two Extreme Examples of Indifference
Curves
• Perfect Substitutes
– Two goods with straight-line indifference
curves are perfect substitutes.
– The marginal rate of substitution is a fixed
number.
Figure 5 Perfect Substitutes and Perfect
Complements

(a) Perfect Substitutes

COKE

I1 I2 I3
0 1 2 3 PEPSI

Copyright©2004 South-Western
Two Extreme Examples of Indifference
Curves
• Perfect Complements
– Two goods with right-angle indifference
curves are perfect complements.
Figure 5 Perfect Substitutes and Perfect
Complements

(b) Perfect Complements

Left
Shoes

I2
7

5 I1

0 5 7 Right Shoes

Copyright©2004 South-Western